Yield compounding is a method for value opinions. It is also known as discounted cash flows and pro forma modeling. It is one of the four most used methods to determine the value of a property. Three other methods are direct comparison, the cost approach, and direct capitalization. Each of these has a different implementation procedure and is suitable for different types of commercial properties.
Difference Between Yield Compounding and Direct Compounding
The main feature that differentiates performance compounding from direct compounding is the ‘time period’. The former takes more time for analysis. It produces a more dynamic representation of cash flows, and not for a single year’s cash flow. In this method, the calculation is made for several years instead of a single year. It is shown on a pro forma statement that mentions the mortgage payment and all other related expenses in the reconstructed income and expense statements.
What is included?
In yield capitalization, experts assess the value of a projected income stream from discounted cash flows. This procedure converts future income from a property into a present value. This is done by discounting each year’s revenue at an appropriate discount rate. For the evaluation of irregular income flows, the variables are anticipated and taken into pro forma statements. Rent growth is one of the most common variables in commercial real estate. In the Capitalization of Yield, the amount and times of cash flow are considered. It also implies the growth or decrease in the value of assets.
What is Cashflow?
It is the pattern of income and expenses of a company or an individual. It is the net income or cash receipts of one or several assets in a given period of time.
Popular with commercial real estate owners
Yield compounding is very popular. Real estate agents and investors trust this method of evaluating properties. This is because it provides accurate estimates that are closer to the factual data.
Statement Example
A typical Yield Capitalization statement involves several calculations, including mortgage, potential rental income, operating expenses, non-operating expenses, gross operating income, net operating income, marginal cash flows, etc. All calculations are carefully done for accurate results.
Advantages and disadvantages
All value opinion methods have their advantages and disadvantages. If you implement the yield capitalization method of property value estimation, you will notice that it results in higher prices for sellers. Attract new buyers. It only suits sophisticated customers.